The Chinese credit crunch

Coface, one of the world’s biggest credit insurers, make a good point in today’s FT.

Whilst the world seems to have paused for breath on the way to global meltdown the cracks are beginning to show before the next step down.

With the massive fall in exports, the inability of Chinese companies to pay suppliers was always going to happen. Only now are we getting the details.

So what are the implications? My belief is that credit management in China has been very poor in the past and that these bad decisions could lead to a chain reaction of failure across the supply chain.

A rapid deterioration in the ability of Chinese companies to honour payments to their suppliers as a result of the economic crisis is significantly increasing the risk of doing business in China, according to Coface, one of the world’s biggest credit insurers.

Xavier Farcot, who heads the French insurer’s underwriting and claims business in China, said the cost of insuring against customers defaulting on payments in domestic trade had risen by 30 per cent since the financial crisis, even for the best customers who have not made any claims previously.

“It is a reflection of the change in the overall risk environment [of selling to Chinese buyers],” said Mr Farcot.

Chinese companies, particularly in the export-oriented technology and electronics manufacturing sectors, faced a liquidity crunch at the end of last year as China’s exports plummeted. Many of them were also unable to access bank loans to tide them over the tough times, especially if they were small to medium-sized private businesses, said Mr Farcot.

Even though Chinese banks, unlike their western counterparts, have ample liquidity, “they are accustomed to lending to large state-owned enterprises rather than small companies who often do not have large resources or equity”, he said.

This cash crunch forced many Chinese companies to turn to their suppliers for credit, thus forcing the pain up the supply chain.

Nearly 90 per cent of Chinese suppliers are extending credit to their domestic customers on more than half of their sales, compared to just 70 per cent a year ago, according to Coface’s annual survey of the country’s corporate credit management practices.

This was bad credit management, said Mr Farcot. “Now is not the time to extend credit, it is time to restrict it,” he said. Most Chinese suppliers, however, have never experienced such a downturn.

“A lot of these companies never had to deal with the problem of not getting paid, because sales had always been increasing,” he said, “There’s not enough financial resource, not enough management.”

As well as customers demanding longer payment terms, the vast majority of Chinese suppliers said they had increasing problems with overdue payments last year. A quarter of them said accounts that were overdue by more than half a year now made up more than 2 per cent of their sales, which “is usually the threshold above which you start running into problems”, Mr Farcot said.

Originally published at the China Economics blog and reproduced here with the author’s permission.

One Response to "The Chinese credit crunch"

Victor Shih April 15, 2009 at 12:37 am

Yes, yet NPL ratios are going down! How is this the case? First, CBRC increased NPL reserves, so banks can use reserve to write-off immediately before NPLs even show up. Also, increasing credit quotas mean the banks can roll over NPLs. How long can this game last?